In a sluggish economy, niche airlines take off

ChristopherHinton

NEW YORK (MarketWatch) — Airline investors retreated this spring as leisure-travel demand wavered and fuel prices clung to their highest levels in more than two years, but they left some underpriced stocks in their wake, according to one analyst.

“Our outlook remains moderately bullish,” Ray Neidl, aerospace specialist with Maxim Group, said in a Friday note to clients in which he acknowledges the economy is starting to look more “sluggish.”

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Conspicuously absent from Neidl’s list are flag carriers United Continental Holdings
UAL, -0.79%
Delta Air Lines
DAL, +0.70%
US Airways Group
LCC, +0.00%
and AMR Corp.
AMR, -2.56%
the parent of American Airlines. Shares of the major airlines have growth potential, but they also face more risk in an environment that could dissuade business travelers from flying.

“For the large carriers, we do not want to see growth but capacity cuts to support [ticket] pricing in a high-fuel-cost, weak economic environment,” Neidl said. “For the smaller carriers with a profitable, growable niche, or the Latin airlines in high-growth markets, we believe that they can support profitable growth and a premium should be [added when] valuing these stocks.”

Trio trading at discounts to projected growth

Alaska, Hawaiian and Spirit represent three of the best of those niche players.

Reuters

AMR Chairman and CEO Gerard J. Arpey reacts as Southwest Chairman and CEO Gary C. Kelly answers a question at April’s Society of American Business Editors and Writers conference in Dallas.

Alaska Air expects to grow between 7% and 9% annually along the U.S. West Coast, while Hawaiian has the opportunity to add various Asian points over the next five years or more to tap the region’s growing middle-class demand for exotic vacations to its home islands.

And though there are no growth projections yet for Miramar, Fla.–based Spirit, which began trading last week, the assumption is that the budget carrier will be able to grow its revenue around 15% annually for the foreseeable future.

Hawaiian currently trades at about 12 times its 2011 Wall Street estimate, while it should be trading closer to the midteens, Neidl said.

Alaska trades at a multiple of roughly nine times its profit estimate but, in the analyst’s view, it should be trading closer to a 12 multiple.

Shares of Alaska closed Friday at $63.95, off about 2.6%, amid a broader market decline, but they’re up about 9% in the past three months.

For comparison, the NYSE Arca Airline Index
XAL, +2.03%
is off about 1.4% over the same period. In the last week, the sector benchmark has declined about 7%.

Shares of Hawaiian Airlines fell nearly 1% to close at $5.53, and the stock is down about 17.5% since early March after an earthquake and tsunami in Japan led to a drop in Hawaiian vacationers from that country.

Spirit’s shares last traded at $11.96, up a fraction and having added less than 1% since its May 26 debut.

In the high-growth economies of Latin America, Santiago, Chile–based Lan is expected to merge with Brazil’s Tam SA
TAM, +1.15%
by year’s end, which would expand operating margins and also benefit other regional carriers such as closely held Azul Airlines and Gol Intelligent Airlines
GOL, -0.60%
Neidl said.

Currently Lan shares trade at about 21 times the average 2011 earnings estimate on Wall Street, but that would be considered soft if the merger with Tam goes through, he said.

“The high-growth Latin carriers should be an area that investors should not overlook, since they are located in areas where the macroeconomic conditions are promoting strong growth,” Neidl said. “There remains room for continuing profit improvement through tighter yield management.”

Copa, meanwhile, trades at about 11 times its average estimate, while it should be trading somewhere in the midteens, the analyst said.

U.S.-listed shares of Copa fell 2% to close at $61.18, leaving the stock up 11% in the past three months. Shares of Lan slipped a fraction to $28.78, but the stock’s moved up roughly 4.5% since early March.

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